Bedrock’s Newsletter for Friday 25th November 2022
Posted by Carlota Vandekoppel on
Friday 25th November 2022
After their dramatic leap up on 10th November – sparked by a gentler-than-expected US CPI print, as discussed in our last missive – markets seemed to take a breather, entering a period of rather benign stasis as the S&P 500 traded within a narrow 122-point band and climbed a gentle +0.3% between the closes on 11th November and this Tuesday. However, this Wednesday’s release of decidedly dovish minutes from the last Fed meeting stoked some pre-Thanksgiving cheer, causing the S&P 500 to add another +0.6% (on top of +1.4% the previous day), while the more rates-sensitively tech-heavy Nasdaq gained +1.0%. US markets were closed for the holiday yesterday, allowing US traders to step away from their screens and gorge themselves on turkey and pumpkin pie. Whether these traders return with indigestion for today’s truncated trading and walk back the week’s gains in view of what remains an unfriendly macroeconomic outlook remains to be seen. The US 2s10s yield curve on Wednesday hit its steepest inversion since the early 1980s – an indicator of recession. While American investors were busy toasting their forefathers’ apparent wisdom in forsaking the Old Continent, European indices nonetheless yesterday climbed to their highest point in 3 months, encouraged by an unexpectedly bullish Ifo measure of German business confidence, continuing the buoyant mood that has held across developed markets in the last weeks. Even if markets have largely been well behaved, there has still been a flurry of high-stakes diplomacy in the last fortnight, some of it enough to move markets on the day and other developments more inclined to shape global economic trends over a longer timeframe. Both are worth a recap here.
The action was centred in and around the two big set-pieces of the G20 and COP 27 – the former the summit gathering of the 20 largest economies, the latter the annual meeting of parties to the United Nations’ UNFCCC climate treaty (i.e., most countries on earth). The G20 summit, hosted by Indonesia, was billed by some observers as the first summit of the second Cold War. The stakes were undoubtedly high going into the meeting but all told the outcomes were rather encouraging. Meeting in the singular is perhaps a misnomer; though a plenary session of all the leaders is the centrepiece, G20 summits are really an opportunity for some high-powered speed dating as world leaders engage in a complex choreography of bilaterals. Prime billing went to Joe Biden and Xi Jinping as leaders of the protagonists of this putative second Cold War, who held their first face-to-face as presidents. Sino-American relations have deteriorated markedly since the pair last met in person (in their earlier vice-presidential roles) and the simple fact of their meeting was already a positive signal. At three hours, the talks even overran, pointing both to a bulging agenda of issues demanding attention and to an encouraging willingness to jaw-jaw and not war-war. While the positives should not be overplayed, the tension in recent years has been such that Biden and Xi’s agreement to re-establish communication channels on global issues including climate change and economic stability was a meaningful step – and set a more positive tone for the G20 summit itself. Biden’s emphasis that US policy on Taiwan was unchanged (after recent statements had suggested otherwise) helped lower the temperature. Xi was on only his second trip abroad since the pandemic began and his first since October’s Party Congress confirmed his third term – and Beijing clearly intended this return to the world stage to show a more conciliatory face than of late. Building on the positive momentum of the Biden talks, Xi had cordial meetings with a string of US allies, an effort that continued on to Bangkok where he met Japanese Prime Minister Kishida Fumio in the margins of an Asian summit; the two agreed to mend relations that had grown frosty. After his Xi meeting, Biden told reporters he ‘absolutely believe[d] there need not be a new Cold War’ – rather undermining the commentariat’s Cold War II schtick. But reference to the twentieth-century standoff is anyway an imperfect analogy in at least one important regard: the dense web of economic interconnections between the US and China is worlds apart from the anaemic commercial arteries linking the Soviet Union and the West. This time, the economic risks are all the higher (setting aside the doomsday scenario of nuclear conflict). The global fallout from true Sino-US economic decoupling would be very real, a strong countervailing force against globalisation that could entrench another inflationary impulse. That said, the improved mood music from the Xi-Biden talks suggested decoupling contained – which joined positive domestic developments on covid and real estate policy in encouraging the strong rally in Chinese assets since the Congress, which has now begun to lure international investors back to Chinese financial markets (though the surging infections and new lockdowns have given pause for thought since).
If we are on the threshold of another Cold War, this time around Russia has been relegated from leading player to understudy – but that did not stop the question of how to deal with its renewed imperialism being one of the greatest challenges facing this G20 gathering. Here the outcome was about as positive as could be reasonably hoped. There had been a possibility of both Putin and Zelenskyy attending, setting up a first encounter since the February invasion – and perhaps even a dramatic gambit for peace – but ultimately Putin preferred to stay away, fearing he would face similar dressing-downs as at his other recent multilateral forays. The real question was therefore whether G20 members – a diverse grouping encompassing not just the richest democracies, à la G7, but also the leading emerging economies and thus 80% of the global economy – could find a common stance on the war. The answer was mostly yes – at least, enough to avoid Bali becoming the first G20 Summit to fail to agree a joint communiqué. The agreed leaders’ statement declared ‘most members strongly condemned the war’ which was ‘exacerbating existing fragilities in the global economy’. Crucially, the communiqué stated bluntly that ‘the use or threat of use of nuclear weapons is inadmissible’. The Kremlin has repeatedly dangled precisely this threat and the danger remains very real. Such an unequivocal message from a caucus of countries reaching well beyond the US’ immediate coterie was a valuable signal to Moscow that retribution for breaching this atomic taboo would be global. Securing this language in a joint statement was no mean feat: all of this year’s G20 ministerial meetings had failed to do so. Thanks went in no small part to strenuous diplomacy by hosts Indonesia but also India, with support from Brazil and South Africa. This, on top of the role of Turkey and the Gulf States in US-Ukraine-Russia negotiations throughout the summer, underscores the burgeoning role of emergent powers – and the complexity of the present geopolitical moment.
That complexity was much in evidence over in Egypt, where COP 27 negotiators largely failed to make progress on the most urgent challenge of the era, which will determine the viability of whole economies. The most substantive positive to come out of the talks was the creation of a Loss and Damage Fund to help the most vulnerable countries cope with the impact of climate change – though the actual detail of the fund is yet to be hammered out. Another important outcome was the UN’s announcement of stricter criteria for corporates claiming Net Zero plans. Many companies had rushed to bolt these plans on as an attractive PR win but will now have to clear a higher hurdle. But the negotiations failed in their core purpose – collaboratively managing the shift away from legacy fossil fuels – when an effort spearheaded by India and backed by dozens of nations to agree the ‘phase-down’ of all fossil fuels (not just coal, as agreed at last year’s COP 26) was scuppered by a rear-guard action by Saudi Arabia (and other producers) to protect the sole sinews of their power. It was always going to be hard to make progress when each of nearly 200 countries had veto power but these talks undershot already low expectations, amidst accusations of chaotic and opaque management by the Egyptian hosts. Digesting the frustration and acrimony at COP 27’s conclusion, the UN’s boss for the talks has suggested changing how they are run. We will have to await next year’s COP 28 in the UAE to see how far that gets. In the meantime, Biden and Xi’s agreement to resume bilateral climate negotiations between the two biggest emitters offers some hope of renewed urgency.
Taking stock after weeks of high-stakes diplomacy, we do not share the view evinced by some observers that we have already entered a multipolar world. For now, we see a more complex geopolitical moment of contested polarity. A positive development of the last fortnight’s diplomacy is the apparent step back from renewed, adversarial bipolarity akin to the Cold War, which would risk fracturing global investment opportunities. But the recent geopolitical wrangling suggests we may yet settle into a more truly multipolar world of uncertain and shifting partnerships. Most of these longue durée considerations are for the politicians to worry over and will not move markets in the immediate view. But it behoves long-term stewards of capital to weigh how these shifts may reshape global patterns of trade and investment. In the here-and-now, these developments have demonstrated global governments’ profound difficulties in finding common purpose to address threats to the global economy that remain very real – and perhaps more so than markets are really pricing, especially after the latest rally in risk assets. In light of a deteriorating global outlook, with risks still heavily skewed to the downside, we believe that there is increasing value to be had in holding interest rate duration in portfolios (particularly those geared towards capital preservation).
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